The restaurant on the ground floor of your mixed use building is damaged when a van driven by a drunk driver hops the curb and smashes through the plate glass window. Your insurance company pays for the repairs. This gives the insurer the right to sue the driver of the van to recover the amounts that it paid. This is "subrogation". Subrogation is a right that inures to an insurers that pays a claim on behalf of its insured. The right of subrogation means, essentially, that when an insurer pays a claim, it then has the right to "step into the shoes" of the insured vis-à-vis the person who caused the damage or loss.
Subrogation arises only with respect to rights the insured has against third parties. Therefore, it has long been held that no right of subrogation can arise in the insurance company with respect to a co-insured of the insured.
For nearly two decades Minnesota common law has held that the term "co-insured," in the absence of an express provision to the contrary, included, for purposes of a landlord's casualty insurance policy, any tenants of the landlord, thus preventing an insurer from recovering from a tenant any amounts paid to the Landlord on a casualty loss which was the result of negligence by a tenant. United Fire & Casualty Co. v. Bruggeman, 505 N.W.2d 87, 88-90 (Minn. App. 1993). Bruggeman determined that the landlord and tenant were co-insureds because (1) each had an insurable interest in the property--the tenant had a possessory interest and the landlord held fee title--and (2) that by paying rent, the tenant was indirectly paying landlord's insurance premiums. This had been the default rule in cases where the parties to a lease had not expressly agreed to a waiver of subrogation, to the procurement of insurance to cover a particular loss, or to the allocation of financial responsibility for such loss. In such cases, a landlord could be sanguine that its tenants would not be subject to suit by an insurer as a result of the tenant's negligent conduct.
This rule was recently abrogated in the case of RAM Mutual Insurance Company v. Rohde, 820 N.W.2d 1 (Minn. 2012). RAM expressly overruled Bruggeman, basing its ruling on a fresh consideration of whether an insurer may recover from an insured's tenant. In reaching its result, the Minnesota Supreme Court recognized that courts throughout the country have followed three different approaches in addressing this issue: (1) some courts, like in Minnesota, have adopted the Bruggeman approach, denying an insurer the ability to recover from the insured's tenants (the "no-subrogation rule"); (2) some courts have adopted the opposite approach, allowing an insurer to pursue subrogation claims against the insured's tenants, absent an express agreement governing the specific situation at hand (the "pro-subrogation rule"); and (3) the last group of courts have pursued a middle ground, adopting a case-by-case approach in which courts consider the reasonable expectations of the parties under the facts of each case to determine if an insurer should be allowed to recover from the insured's tenant (the "case-by-case approach").
Rather than the strict no-subrogation rule of Bruggeman, the Minnesota Supreme Court adopted the case-by-case approach, basing its holding on three reasons.
First, the Court concluded that the case-by-case approach is best suited to the areas of law implicated by the subrogation question--insurance law and landlord-tenant law, both of which are grounded in contractual relationships. By examining the reasonable expectations of the parties, the approach "best effectuates the intent of the parties by eliminating [legal] assumptions altogether." Id. at 12.
Second, the case-by-case approach still takes into account the equitable principles underlying the subrogation actions. Since subrogation merely allows the insurer to step into the insured's shoes, it would be inequitable to accept the pro-subrogation avenue, which allows the insurer to step into the insured's shoes in cases the insured would not be able to--situations in which the tenant nor the landlord would have or did expect the tenant to be liable.
Third, the case-by-case approach is more consistent with Minnesota's public policy of holding people who cause damage accountable for their actions than the no-subrogation rule of Bruggeman.
Therefore, rather than a bright-line rule that an insurer may never recover from the insured's negligent tenant, the Minnesota Supreme Court created a rule in which such recovery can sometimes be available, depending on the circumstances. This is important for commercial landlords, as the new possibility for an insurer to file suit against a tenant can lead to tenant financial instability and lease defaults.
The uncertainty resulting from RAM Mutual's case-by-case approach would not apply where a lease contains provisions discussing the allocation of financial responsibility for injury or damage. One important way to explicitly deal with such allocation is contractual waivers of subrogation. Waivers of subrogation in commercial leases defeat the claims a landlord may have against a tenant and vice-versa. Generally, this also defeats the subrogation rights of the insurer as the insured no longer has any rights for the insurer to step into. "Such agreements do not contravene public policy, are valid, and are enforceable." Great Northern Oil Co. v. St. Paul Fire & Marine Ins. Co., 291 Minn. 97, 100-101, 189 N.W.2d 404, 407 (1971). Therefore, in the wake of RAM Mutual, landlords and tenant should review their leases to be sure they contain well-crafted waivers of subrogation. The explicit naming of the parties as additional insureds to one another's insurance policies may also be warranted.
Lindquist Gets Real is a periodic publication of Lindquist & Vennum LLP and is intended to provide tips and basic information about real estate law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.